Ask Dr. Don
Today, Dr. Don explains the time value of money and discusses negative amortization on a home equity loan.
Time value of money
Dear Dr. Don,
If you're trying to decide whether to buy an annuity, don't forget to consider the tax implications of your actions. Don't just rely on your investment professional; consult with a tax planner too.
Dear Dr. Don,
Your loan documents spell out how often the interest rate is adjusted, the index and the spread to the index. The typical home equity loan is priced off the prime rate. Since the prime rate usually increases when the Federal Reserve raises the Fed Funds rate, the interest rate on these loans are going higher. Most variable rate home equity loans have a spread up to 1 percentage point over the prime rate. You can follow the prime rate and other variable rate indexes on this site's Watch Market Rates page.
A variable rate loan can have both interest rate caps and payment caps. Payment caps limit the increase in the mortgage payment. Your loan may well have an initial 12-month payment cap. Payment caps are helpful in budgeting. You'll know for certain what your payment will be during the first 12 months, but if the interest rate goes higher you'll experience negative amortization. Interest rate caps limit the increase in the variable rate. There are periodic caps and lifetime caps. A periodic cap limits the interest rate increase for one reset period while a lifetime cap spells out the highest interest rate you can be charged on the loan.
Can you be in a situation where your loan balance is increasing? Yes, you can. Since your loan is so recent, make sure you won't incur any prepayment penalties if you decide to pay off the loan.
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-- Posted: June 21, 2000